The Consolidated FINRA Rulebook: The Conduct Rules Excerpt - Rule 2114 Recommendations to Customers in OTC Equity Securities
Preliminary Note: The requirements of this Rule are in addition to other existing member obligations under FINRA rules and the federal securities laws, including obligations to determine suitability of particular securities transactions with customers and to have a reasonable basis for any recommendation made to a customer. This Rule is not intended to act or operate as a presumption or as a safe harbor for purposes of determining suitability or for any other legal obligation or requirement imposed under FINRA rules and the federal securities laws.
History
Amended by SR-FINRA-2008-055 and SR-FINRA-2009-033 eff. June 15, 2009, SEC Release
No. 34-59605, 74 Fed. Reg. 13,283 (March 26, 2009).
Adopted by SR-NASD-99-04 eff. Oct. 30, 2002.
FINRA Regulatory Notices: 02-66, 09-20.
Analysis
FINRA Rule 2114, which is based on NASD Rule 2315, addresses potential fraud and abuse in transactions that involve securities that are not listed on an exchange and other higher risk securities. In adapting the NASD rule for the Consolidated FINRA Rulebook, FINRA made four important substantive changes that:
- broadened the scope of the rule to include any OTC equity security;
- added a definition of current material business information;
- eliminated an exemption for securities with worldwide daily trading volumes of at least $100,000; and
- allowed the due diligence review to be conducted by a General Securities Principal (Series 24) or a General Securities Sales Supervisor (Series 8 or 9/10) or someone supervised by either of the above.
Under NASD Rule 2315, a member must conduct a due diligence review of an issuer's current financial and business information before recommending the purchase or short sale of a security that is published or quoted in a ''quotation medium'' and which is not listed on Nasdaq or a national securities exchange, or are listed on regional securities exchange and do not qualify for the dissemination of transaction reports via the Consolidated Tape. FINRA, seeking to address what it sees as a similar risk of fraud and manipulation, expanded the rule by applying it to any ''OTC Equity Security'' regardless of whether it is published on a quotation medium--basically, FINRA Rule 2114 applies to any non-exchange-listed security and certain exchange-listed securities that do not otherwise qualify for real-time trade dissemination.FINRA also discounted complaints that the due diligence review would result in processing delays in purchasing OTC Equity Securities since the due diligence should be completed before the recommendations are even made. Finally, FINRA rejected a suggestion that firms who generate less than 5 percent of their commission revenue from OTC Equity Securities transactions and do not make a market in such securities be exempted from Rule 2114. FINRA believed this proposed exemption would allow a significant number of OTC Equity Securities to avoid the due diligence review and thereby undermine FINRA's investor protection goals.
The Consolidated FINRA Rulebook: The Conduct Rules, which is the source of the above commentary, is a thorough yet concise reference work, written, compiled and edited by leading practitioners. It is a reasonably priced desk manual that is available may be purchased by calling 1-800-223-1940 (outside the USA, call 518-487-3000). The Guide should be at the fingertips of every individual working in the Corporate Legal field. The text includes policy discussion to support the shift to a principles-based approach, and a chart that maps the substantive relationship between the transitional and consolidated rules. Instead of a numbing procession of rule numbers, scrolling across roughly 20 pages in the FINRA charts, the Rulebook chart presents a more concise—and incisive—overview of the rules consolidation process. The analysis sections are well-written and informative, but the inclusion of the chart is what makes this text an essential part of the corporate practitioner’s library.